Accounting Fundamentals: Chapter 9 - Accruals & Prepayments

What is the accruals principle?

Expenses and income are recognised in the period they relate to, not when cash is paid or received.

Why are accruals and prepayments needed?

To match income and expenses to the correct accounting period.

What is an accrual?

An expense incurred but not yet paid by the period end.

Where is an accrual shown in the financial statements?

As a current liability in the SoFP

Journal to record a closing accrual?

Dr Expense
Cr Accrual (liability)

Effect of an accrual on profit?

Increases expenses → reduces profit.

What is a prepayment?

An expense paid in advance that relates to a future period.

Where is a prepayment shown in the financial statements?

As a current asset in the SoFP.

Journal to record a closing prepayment?

Cr Expense

Effect of a prepayment on profit?

Reduces expenses → increases profit.

How do you calculate the expense for the period?

Cash paid

• Closing accrual
  − Opening accrual
  − Closing prepayment

• Opening prepayment

When is a timeline approach best?

When no opening or closing accruals/prepayments are given.

When are T-accounts best used?

When opening and/or closing accruals or prepayments are provided.

What are the 3 steps for accruals?

• Reverse opening accrual:
  Dr Accruals
  Cr Expense

• Record cash paid:
  Dr Expense
  Cr Bank

• Record closing accrual:
  Dr Expense
  Cr Accruals

Opening journal to reverse an accrual?

Dr Accrual
Cr Expense

What are the 3 steps for prepayments?

• Reverse opening prepayment:
  Dr Expense
  Cr Prepayment

• Record cash paid:
  Dr Expense
  Cr Bank

• Record closing prepayment:
  Dr Prepayment
  Cr Expense

Opening journal to reverse a prepayment?

Dr Expense
Cr Prepayment

How can you spot if an accrual has been treated as a prepayment?

It will incorrectly appear as an asset instead of a liability.

How can you spot if a prepayment has been treated as an accrual?

It will incorrectly appear as a liability instead of an asset.

What is accrued income?

Income earned but not yet received (income in arrears).

Where is accrued income shown?

As a current asset in the statement of financial position.

Journal for accrued income?

Dr Accrued income (asset)
Cr Income

What is deferred income?

Income received in advance of providing goods or services.

Where is deferred income shown?

As a current liability in the statement of financial position.

Journal for deferred income?

Dr Income
Cr Deferred income (liability)

How do you calculate income for the year?

Cash received

• Closing accrued income
  − Opening accrued income
  − Closing deferred income

• Opening deferred income

Where do accruals and prepayments affect the profit or loss?

They adjust expenses and income to the correct period.

Where do accruals, prepayments, accrued income and deferred income appear?

In the statement of financial position as assets or liabilities.

What does ICAEW commonly test with accruals and prepayments?

• Period expense/income calculations
• Correct journals
• Asset vs liability classification
• Use of T-accounts